SCGhealth Blog

Tax Court: Forgiveness of a recruitment loan can be taxable income

Friday, May 29, 2015

By: Marla Durben Hirsch

If you’re considering a hospital/physician recruitment agreement with a loan or income guarantee, remember that the doctor will likely have to pay tax on that money if the hospital forgives the debt. 

The Tax Court recently sided with the IRS that that money a physician received from a hospital as part of an income guarantee became taxable income when the hospital forgave and cancelled the loan. 

Darrel Wyatt, an obstetrician/gynecologist, was recruited by Putnam, Florida’s Putman Community Medical Center, to establish a practice in this medically underserved region. As part of the deal, he agreed to stay for at least four years, maintain active medical staff membership at the hospital and other obligations. Wyatt and the hospital signed a Net Collectable Revenue Guarantee with Repayment Forgiveness, where the hospital would advance Wyatt a monthly income guarantee of $32,953 for twelve months. The contract allowed Wyatt to request a deferred payment plan or for the hospital to have him sign a promissory note or perfect a security interest for repayment of the monies. However, those contingencies never occurred because Wyatt complied with all of the obligations in the recruitment agreement, causing the hospital to forgive and cancel the loan. 

Wyatt included the income guarantee amounts on his 2009 tax return but never paid estimated tax on the money nor when filing the return. The IRS notified him that he owed tax on that amount, plus interest for failure to timely pay the tax. 

Wyatt challenged the tax assessment. He first offered a compromise payment based on “doubt of liability” but didn’t include the loan amount forgiven as part of that compromise. The IRs considered and ultimately rejected the offer because the doubt of liability had not been established. 

In trial, Wyatt argued that he wasn’t liable to pay tax on the forgiven loan because it wasn’t income – it was really a “nonrecourse” loan and he was never personally liable for repayment when it was cancelled and forgiven. Wyatt said that he wasn’t personally liable for repayment because he had never signed a promissory note, entered into a deferred payment plan or perfected a security interest. 

 The tax court disagreed... Money in a loan is not part of gross income when it’s lent because there is an obligation to repay it. But if the taxpayer ends up not having to repay it, it may then be considered income. 

The court said he was still personally liable for that debt even though he hadn’t signed a signed a promissory note, entered into a payment plan or perfected a security interest. The reason he didn’t sign one of these repayment agreements is because he didn’t need to – the loan had been forgiven when he met his obligations in the recruiting agreement. Moreover, pursuant to the agreement the hospital could have taken legal action to collect any loan amounts due from Wyatt had he not met his obligations. 

Wyatt also asked that the “addition” to tax – i.e., interest – not be applied here because there was “reasonable cause” for him not to have paid the tax in 2009. He claimed that he would have incurred financial hardship if he had paid the additional tax on the forgiven loan back then. He also asked for an interest abatement. 

The court didn’t buy any of it. Wyatt he didn’t demonstrate any reasonable cause to forgive the interest or not pay any estimated taxes, for that matter. And he didn’t qualify for an interest abatement because he didn’t ask for one in a timely manner. 

The Lesson: 

Physician/hospital recruiting agreements are a great tool to incentive physicians to relocate to areas where they’re needed. But the tax rules still apply.

It’s also worth noting that Wyatt appears to have represented himself in his challenge of the tax assessment. In retrospect this may not have been the wisest move. Putting aside whether there were additional legal arguments in his favor he might have made had he known about them, at least a competent tax advisor/counsel would have filed the requisite request for the interest abatement before the deadline and/or perhaps could have negotiated a compromise settlement that the IRS would have accepted and avoid the additional time and expense of tax court. 

Resource: Tax Court ruling

Make sure employees feel comfortable reporting concerns to compliance – or it could prove costly

Monday, April 20, 2015

by Scott Kraft

We would all like to think that, when it comes to protecting the assets and reputation of the physician practice, our employees will stand up and do the right thing. Generally, it’s a true statement.

The lesson for health care entities to learn, as has been shown time and time again, is that prompt employee reporting of compliance suspicions takes more than just hoping that they’ll do the right thing. You need to create an atmosphere that encourages internal reporting and provides protection and potential anonymity for those who do report.

You also need a culture that demonstrates you’ll act on these complaints promptly and, when needed, take quick action. Nothing can have a more chilling effect on employee reporting to compliance then when the employee is confident wrongdoing is occurring, but there is no follow up or action taken by the entity.

As you’re about to learn, you also need to maintain prudent financial and accounting controls that don’t give any single individual within the organization too much authority when it comes to processing invoices and spending money.

The case study here involves Memorial Herman Hospital System in Houston, Texas. As reported by the Department of Justice, a Herman Memorial employee, Kenneth Wild, is accused of stealing nearly $10 million from the system over a 14-year period.

Wild faces up to 20 years in prison, in addition to a $250,000 fine and the need to potentially make restitution.

For an entity as large as Herman Memorial, the theft was brazen in its scope and size, but was also very simple for Wild.

Shortly after joining management in March 2001, Wild began to process invoices from a company called Digital Designs Limited. Memorial Herman and the Department of Justice would later learn that the company was very limited, in that it furnished no design services whatsoever.

Wild is accused of setting up Digital Designs Limited in 2001, submitting phony invoices for services not rendered to Memorial Herman and then, in his role as manager of printing and mail services, processing and approving the invoices and submitting them for payment. Accounts payable was processing the invoices and distributing the payments via checks sent in the mail.

Before we get into the whistleblower’s role in ending the theft, let’s take a step back and talk about the accounts payable process that allowed this to happen.

First, any new vendor brought into your system should be independently approved by your accounts payable staff or, if the practice is smaller, someone that is not directly related to the provision of the services being paid.

In Wild’s case, he didn’t personally cut the checks for this fake vendor, but he brought the vendor invoices into the organization and signed off on them. Memorial Herman then spent $10 million before anyone stopped to wonder if the money going out to the vendor was appropriate. Nobody even stopped to wonder what it was that the vendor was doing for such large sums of money.

Don’t think that Wild didn’t notice. In all likelihood, before he was promoted, he paid very close attention to the manner in which the company processed and paid its invoices. He saw where the gaps were in the process and he exploited them. He set up the fake company and began sending the fake invoices within 2 weeks of getting the new job.

What brought Wild down
Wild’s alleged thefts were ultimately foiled by an anonymous whistleblower, who left a written note for the chief audit and compliance officer that was anonymous, but instructed that the company check out Digital Designs because it was a ghost account.

The compliance officer almost certainly wishes that notice had come sooner – after all, the group lost more than $10 million over a 14-year period and paid out more than 200 invoices to Digital Designs, for which absolutely no work was done.

But give them credit for this – they didn’t sit on the information, or not take the complaint seriously. The handwritten, anonymous letter was delivered to the compliance officer on March 11, 2015, and the press release from the Department of Justice announcing the arrest of Wild was released on March 23, 2015.

The investigation revealed that the Digital Designs account functioned as a pass-through account, with the money ultimately going back to Wild, who spent in on living a more extravagant lifestyle.

Credit goes to the employee who felt compelled to leave the anonymous note that brought down Wild and ended the threat. It’s unclear if Memorial Herman could have done anything to get a different result, in terms of opening up lines of communication.

Don’t let that stop you – it’s critical for everyone in your organization to know how to find the compliance officer, or an anonymous compliance hotline, to be able to share suspicions about things that may be going on within the organization.

No employee, faced with viewing potential wrongdoing, should have to wonder what the best remedy is for reporting it to the organization, or how to report it to the organization. When those things are happening at your practice, the odds of you being the victim of a long-term embezzlement scheme increase considerably for lack of a reporting mechanism.

Make sure you set a strong non-retaliation policy for reporting whistleblowers or those suspected of wrongdoing. Print the hotline number on employee badges, in employee break areas, potentially even on employee pay stubs.

The compliance officer or any member of the compliance depart should be well known to all employees of the practice and considered to be approachable and interested in hearing of any instances of even suspected wrongdoing.

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